Why do wages rise in a recession?

This morning, Rutgers University released its Labor Scorecard, which confirmed the high unemployment figures published by the Labor Department earlier this week.  Someone in the PR department at Rutgers caught this report on its way out the door and added a little spice to the press release, noting that “though unemployment has risen in 2009 to its highest rate in 26 years, all is not gloom and doom for America’s workers on Labor Day…average inflation-adjusted earnings have actually increased for those still collecting paychecks.”

Beth Defalco of the Associated Press picked up on the hint of optimism — and the promise of a real story on a slow news day — by noting that the wage increase is one of the “encouraging trends” that we can all look forward to “this Labor Day.”  Not only is the recession not that bad, but we receive this happy news on a national holiday dedicated to the American worker!

Just as you were counting your blessings that you still had a job, now you have something new to worry about: should you ask for a raise?  (Tip: If your company recently experienced mass layoffs, etiquette specialists recommend you wait at least three weeks before confronting your boss.)

The correlation between unemployment rates and wages has long been known.  In a recent column in The New Yorker, James Surowiecki observed: “even during the early years of the Great Depression, manufacturing workers actually saw their real wages rise.”  Surowiecki draws the conclusion that wages are “sticky” during downturns because employers are afraid of an economic phenomenon known as “adverse selection.”  In other words, after laying off half the staff, your boss won’t cut your salary because he doesn’t want you to walk out the door.

In fact, this “trend” is nothing more than a statistical side-effect.  A deeper dive into the unemployment figures from the BLS reveals that the people losing their jobs right now are low-wage earners.  It is true that unemployment is on the rise across all classes, but the high-paid members of the “creative class” — such as senior managers and doctors — are only experiencing 4-5% unemployment, compared with working class unemployment of 15%.  Working class unemployment is also accelerating more rapidly than that of the creative class.

To understand how higher unemployment among the working class translates to a general increase in wages, it may be helpful to consider the labor dynamics of a simple island economy.  On our island, there are four workers making $25,000 a year and one supervisor making $50,000 a year.  Since there are no others on the island, we are at full employment.  Until, that is, a major recession rolls in, forcing the supervisor to lay off one of the workers.  Now unemployment is at 20%.

But something magical has happened to the average income of the small island economy.  Even though the salaries all stayed the same, the average income rose from $30,000 (before the layoff) to $31,250, an increase of 4%!

Of course, no one is better off in our island economy.  The wage increase is just a statistic.

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